By Stephen Metcalf - Private Client Tax Senior Manager at Kreston Reeves
There is a lot of talk about the state of the property market at the moment, and indeed the wider economy in the UK. Political uncertainty following an election that couldn’t produce a clear government, and what some are seeing as a poor start to Brexit negotiations, clearly are causing nerves for many.
So what would a slowdown or a crash look like?
Although property remains one of the safest places you can put your money long-term - the UK property market is highly resilient, underpinned by high demand and short supply, and the lettings market always tends to flourish in times of uncertainty - it’s always wise to plan for the worst-case scenario.
Firstly, think of property prices stagnating, or even falling. Will your property portfolio stop increasing in value, or even decrease? According to the Office for National Statistics, in the year to May 2017, the average UK price rise has dropped to 4.7% from 5.3% the month before. Clearly different locations will fare differently over time, and even different types of property will have differing fortunes. East of England is still seeing increases of 7.5%, whilst the North East of England increased by only 1.6%, with London achieving 3%. However, looking at Halifax figures, these growth figures are perhaps hangovers from late last year and earlier this year, as they state that average UK house prices fell by 1% in the month of June 2017.
But if you are not selling or buying, does it matter what the values are doing? Perhaps not in the short to medium term if you are focusing on maximising income from your current portfolio.
Secondly, is it possible that rents will fall? Will tenants struggle to pay rents? With price inflation currently outpacing wage inflation, something might have to give for some tenants. We still don’t know yet whether price inflation has reached its peak following the devaluation of sterling since the Brexit result, even though there was some welcome news recently with the rate dropping in June 2017 to 2.6% - down from a 2.9% high in the previous month.
Ever-increasing inflation could potentially have a double effect on some landlords, with the threat to their tenants’ affordability but also the potential interest rate rise which would almost certainly make mortgages more expensive than their current historical lows.
All in all, having come through some tough tax changes which hit a lot of landlords hard, can they really come through a downturn in the market as well? Undoubtedly there would be some casualties, and they are likely to be the least prepared.
What should you be doing to prepare yourself?
1) Plan: Have you got a short term/medium term plan? Does this need adjusting to factor in the current market? What about the longer term? What are your ultimate goals with the portfolio? It is always useful to consider the longer term plan. What are you really planning on getting out of the portfolio and when?
Some landlords will have mapped out exactly where they are and want to be; when they are planning on investing further; and when they are going to sell up and cash in on the investment. Perhaps the portfolio is not going to be sold, but passed on to the next generation.
Others may have started out as accidental landlords, perhaps inheriting property or just keeping hold of an old home when they move somewhere else. Are you one of these landlords, have you thought about what you want to do with your portfolio?
2) Seek advice: Cost cutting is clearly an initial instinct, and it makes great sense to ensure that unnecessary spending is stopped or reduced. However getting good advice from the right people can itself pay dividends, be it a letting agent who can advise on how to maximise the return on your investment; a lawyer who can ensure that you don’t end up with any legal troubles; a tax adviser who can assist you in minimising the tax cost of owning and letting properties; or good insurance which can cover you when things do go wrong.
Spending some money on your properties to refresh them and make them more attractive to renters, hopefully with a view to increasing rents is perhaps easier these days from a tax perspective. In the past there was a straight 10% of turnover wear and tear allowance for furnished properties, and a restriction for relief for items of a more capital nature, whereas from 6th April 2016, there is now a replacements relief which allows for landlords who let out residential property (furnished or not) to claim for the cost of replacing items such as moveable furniture, carpets, curtains, fridges, freezers, kitchenware and televisions, etc.as a direct reduction against rental profts.
3) Assess your portfolio: Have you got the right properties? As highlighted above, property growth rates differ around the country and change over time. If house prices are slowing or indeed dropping, this might help your Capital Gains Tax (CGT) position on a sale of a badly performing property, as your gain will possibly be lower.
On the other hand, lower growth rates might also been seen by some as an opportunity to pick up a property bargain. Do however make sure you factor in the Stamp Duty Land Tax (SDLT) costs, especially these days with the 3% surcharge.
4) Consider gifting: Is it time to make gifts of property to the next generation? Unfortunately property businesses do not benefit from the useful CGT and Inheritance Tax (IHT) reliefs that trading businesses can access.
If you leave property to your children in your will, there is likely to be a 40% IHT charge after using up the IHT nil rate band and main residence nil band (if you qualify for this). If you gift property during your lifetime however there is a CGT charge on the gain based on the market value of the property at the time of the gift. Therefore if the market has dropped, a gift now might be cheaper than a gift when the property picks up.
5) Consider your mortgage(s): Mortgage interest relief restriction is kicking in. From 6 April 2017, 25% of your mortgage interest will not benefit from higher rate tax relief. If the impact of this means you cannot afford to keep all of your portfolio, consider whether you should be selling your property now if you think values will drop, so you can clear some of the mortgage costs, but do be mindful of the CGT position on a sale.
Alternatively prepare for lower property valuations by looking at your loan to values now and see if you can improve interest rates when mortgage deals are coming to an end.
Many have raised the question of whether it would be better to run the property business through a limited company to avoid these mortgage restriction rules and benefit from lower corporate tax rates. Do be warned however that this is a complicated area (outside the scope of this article), and some nasty SDLT and CGT surprises might be in store for the ill-advised.
6) Finally, consider your income tax position early. If you are organised soon after April tax year end, you can calculate what your tax payments will be up until July the next year. However if you suffer a drop in rents or increased expenditure in the current tax year, by keeping a track of this as you go along, you can apply to reduce the payments on account to reflect a lower tax liability if this is likely to happen. Essentially, this is the behaviour that Making Tax Digital (MTD) and the need for quarterly reporting is trying to encourage and this will clearly bring some benefits.
You may have seen the recent announcement that MTD quarterly reporting is being delayed until at least April 2020, which is probably good news for most as it was felt that taxpayers and HMRC alike were not going to be ready for the original start date. However, it is still going to happen, so why not think now how you will manage this process?
As you can see from the above, there is plenty to think about with your property portfolio, and quite frankly downturn or no downturn, the key to a successful business is to plan as best you can for all eventualties.
For specialist tax advice please contact Kreston Reeves.